The first aspect of a “flash crash” that readers need to understand is that the media uses the phrase as a catch all term to explain any quick and large selloffs that do not have obvious causes. Gold’s approximately $100 sell off on Sunday evening (US)/Monday morning (Asia) is a good example.

The price move happened quickly, hence “flash”, and moved lower by what would generally be accepted as a large amount, hence “crash”. While this gives you a good idea of what happened, it does not in any way provide you with any information as to why it happened. Flash crashes tend to leave market observers scratching their heads and scrambling to find some fundamental cause or reason to explain the move.

More often than not, the narrative that they settle on would include some observation of how markets were illiquid, and possibly some reference to computer algorithms exacerbating the selloff by either withdrawing liquidity, and/or selling even more as the market crashes. This has been the case since 2010, when the term “flash crash” was first coined to describe a quick and sharp ~1600 point round trip move in the Dow (about 1000 points down and 600 up).

At first glance, such a narrative makes enough sense to fulfil our psychological need for rational explanation. However, upon closer inspection, it is quite clear that something else has to be going on, at least with regards to what set off the crash in the first place.

For an asset’s price to fall, someone, or someones, have to be dumping assets into the open market with no regard for how they are moving the market. In other words, someone desperate to raise cash. This implies a broker issuing margin calls to client/clients to make up for shortfalls in their account balance, which is the point where things start to get a little murky. This is because sometimes, traders don’t meet margin calls by dumping the assets which have caused the shortfall.

To be concluded…